Annuity Simply Stated...

Annuities can provide safety, growth and income for as long as you live.

Annuities are financial products sold by an insurance companies. Which allows you to put money aside each year without paying taxes. It can also provide a stream of future scheduled payments you can control. Unlike IRAs, these payments are taxed as ordinary income and there is no income limitation on how much you can place in an annuity.

Annuity Myths and Truths

Myth 1

When I die, the insurance company keeps all my money.

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Myth 2

 Annuities charge high fees and expenses.

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Myth 3

 My agent says I can earn stock market returns with a Fixed Indexed Annuity (FIA).

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Myth 4

The annuity company makes me commit my money for a long time.  Is that fair?

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Myth 5

Annuities are not guaranteed by the FDIC or any other Federal Organization.  Why would I trust an insurance company?

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Comparing the Different Types of Annuities

Fixed vs. Variable Annuities

Fixed annuities pay a “fixed” rate of return. When you receive payments, the monthly payout is a set amount and is guaranteed. Fixed annuities may be a good choice for:

Conservative investors who value safety and stability.
Those nearing retirement who want to shelter their assets from the volatility of the stock or bond market.

Variable annuities, you can invest in a variety of securities including stock and bond funds. Stock market performance determines the annuity's value and the return you will get from the money you invest. The amount of risk you are willing to assume should influence the kind of funds you select.

You may want to consider a variable annuity if you are:

Comfortable with fluctuations in the stock market and want your investments to keep pace with inflation over a long period of time.
Young and want to prepare financially for retirement by reaping the gains in the stock or bond market over the long term.

Types of Fixed Annuities

  • Immediate annuities--start paying income right now (to start in less than one year)
  • Deferred annuities--start paying an income later (anywhere from 1-50 years)
  • Multi Year Guarantee Annuities (MYGAS)--pay a fixed interest rate each year for a certain period of time
  • Indexed Annuities-increase in value depending on the performance of a baseline index like the S&P 500, Dow Jones, Gold, Real Estate, or even a negatively correlated index.

The key characteristic of a fixed annuity is that the principal is FIXED. It is guaranteed by the insurance company. Gains are usually locked in each year, and you can mix and match different types of annuities to create a guaranteed income stream in retirement that is not influenced by interest rates, market fluctuations, or other typical market influences. These are good options for conservative individuals, and are not regulated as an investment, but an an insurance only product.

Payout and Timing Options

Deferred vs. Immediate Annuities

All annuities can be divided into one of the following two categories when it comes to timing of annuity distributions:

Immediate Annuities – These contracts do not have an accumulation phase before payout. As their name implies, immediate annuities begin making payments back to the owner as soon as the contract is in force. 

Deferred Annuities – The principal invested in these contracts will grow for a set period of time until annuitization or systematic withdrawal. 

Lifetime vs. Fixed period Annuities

A fixed period annuity pays an income for a specified period of time, such as ten years. The amount that is paid doesn’t depend on the age (or continued life) of the person who buys the annuity; the payments depend instead on the amount paid into the annuity, the length of the payout period, and (if it’s a fixed annuity) an interest rate that the insurance company believes it can support for the length of the pay-out period.

A lifetime annuity provides income for the remaining life of a person (called the “annuitant”). A variation of lifetime annuities continues income until the second one of two annuitants dies. No other type of financial product can promise to do this. The amount that is paid depends on the age of the annuitant (or ages, if it’s a two-life annuity), the amount paid into the annuity, and (if it’s a fixed annuity) an interest rate that the insurance company believes it can support for the length of the expected pay-out period.

With a “pure” lifetime annuity, the payments stop when the annuitant dies, even if that’s a very short time after they began. Many annuity buyers are uncomfortable at this possibility, so they add a guaranteed period—essentially a fixed period annuity—to their lifetime annuity. With this combination, if you die before the fixed period ends, the income continues to your beneficiaries until the end of that period.

Tax Provisions

Qualified vs. Nonqualified Annuities

A qualified annuity is one used to invest and disburse money in a tax-favored retirement plan, such as an IRA or Keogh plan or plans governed by Internal Revenue Code sections, 401(k), 403(b), or 457. Under the terms of the plan, money paid into the annuity (called “premiums” or “contributions”) is not included in taxable income for the year in which it is paid in. All other tax provisions that apply to nonqualified annuities also apply to qualified annuities.

A nonqualified annuity is one purchased separately from, or “outside of,” a tax-favored retirement plan. Investment earnings of all annuities, qualified and non-qualified, are tax-deferred until they are withdrawn; at that point they are treated as taxable income (regardless of whether they came from selling capital at a gain or from dividends).

Single vs. Flexible Premium Annuities

 Single premium annuity is an annuity funded by a single payment. The payment might be invested for growth for a long period of time—a single premium deferred annuity—or invested for a short time, after which payout begins—a single premium immediate annuity. Single premium annuities are often funded by rollovers or from the sale of an appreciated asset.

Flexible premium annuity is an annuity that is intended to be funded by a series of payments. Flexible premium annuities are only deferred annuities; that is, they are designed to have a significant period of payments into the annuity plus investment growth before any money is withdrawn from them.